Tax laws influence our decisions in life, sometimes implicitly and sometimes explicitly. Knowing and understanding the different ways you can make the tax law work in your favor can significantly impact your financials. Over time, this knowledge can prove extremely useful in cutting your tax bill to the legal minimum.
Today, I am sharing with you information related to education expenses. It’s an essential investment in life but doesn’t need to be financially painful. Some credits reduce tax dollar for dollar, and then some deductions reduce the taxable income.
Let’s take a look.
Credits
A tax credit reduces the income tax you may have to pay.
American Opportunity Tax Credit
You can qualify for American Opportunity Tax Credit (AOTC) if you pay for college expenses for the first four years of college. The maximum amount of credit per student is $2,500. Because AOTC is a refundable credit, even if you owe ZERO taxes, you can still get up to $1,000 refunded to you.
Eligibility
To be eligible for AOTC, the student must:
- Be pursuing a degree or other recognized education credential
- Be enrolled at least half-time for at least one academic period beginning in the tax year
- Not have finished the first four years of higher education at the beginning of the tax year
- Not have claimed the AOTC or the former Hope credit for more than four tax years.
- Not have a felony drug conviction.
Limitations
- To claim the full credit, your adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for married filing jointly).
- You receive a reduced credit if your MAGI is over $80,000 but less than $90,000 (over $160,000 but less than $180,000 for married filing jointly).
- You cannot claim the credit if your MAGI is over $90,000 ($180,000 for joint filers).
Claiming the Credit
Your college will send you a Form 1098-T Tuition Statement. This form will list the amounts you need to enter on Form 8863 to claim the credit.
What is the AOTC worth?
This credit is worth 100% of the first $2,000 you spend for qualified costs and 25% of the next $2,000, totaling $2,500.
Lifetime Learning Credit
Lifetime Learning Credit (LLC) can be used by anyone not eligible for AOTC. As long as you are enrolled in an eligible educational institution, this credit covers all courses, including non-degree courses used to acquire or improve job skills. Per taxpayer, this non-refundable credit is worth $2,000.
Eligibility
To be eligible for LLC, you must:
- Pay for qualified education expenses for higher education (for yourself, spouse, or dependent)
- Be an eligible student enrolled at an eligible educational institution.
- Be listed on the tax return as yourself, a spouse, or a dependent.
Limitations
- To claim the full credit, your modified adjusted gross income (MAGI) must be $52,000 or less ($104,000 or less for married filing jointly).
- You receive a reduced credit if your MAGI is over $52,000 but less than $62,000 (over $104,000 but less than $124,000 for married filing jointly).
- You cannot claim the credit if your MAGI is over $64,000 ($128,000 for joint filers).
Claiming the Credit
Same as AOTC.
What is the LLC worth?
Lifetime Learning Credit is worth 20% of the first $10,000 tuition, for a maximum of $2,000 per taxpayer. To be eligible for the full credit for 2015, your earnings need to be less than $54,000 if you are single or filing as head of household or lower than $108,000 if you are married filing jointly.
Deductions
A deduction reduces the amount of your income subject to tax, reducing the amount of tax you may have to pay.
Tuition and Fees
The tuition and fees deduction is beneficial when you don’t qualify for American opportunity or lifetime learning credits. It allows you to deduct qualified education expenses paid during the year for yourself, your spouse, or your dependent. This deduction is claimed as an adjustment to income and can help reduce your income by $4,000. You can claim this deduction even if you do not itemize deductions on Schedule A (Form 1040).
Eligibility
To be eligible for tuition and fees deduction, you must:
- Pay for qualified education expenses for higher education (for yourself, spouse, or dependent)
- Be an eligible student enrolled at an eligible educational institution.
Limitations
- You can not be claimed by someone else on their tax return as a dependent.
- You can not file as Married Filing Separate.
- No tuition and fee deduction is allowed if your MAGI is larger than $80,000 ($160,000 if you are married and filing jointly).
Claiming the Credit
You can claim the tuition and fees deduction by completing Form 8917 and submitting it with your Form 1040.
How much is the deduction worth?
If your MAGI is not more than $65,000 ($130,000 if you are married and filing jointly), your maximum tuition and fees deduction is $4,000. If your MAGI is larger than $65,000 ($130,000 if you are married filing jointly) but is not more than $80,000 ($160,000 if you are married filing jointly), your maximum deduction is $2,000.
Student Loan Interest Deduction
For those who are out of college or currently enrolled but making payments on their student loan, you are allowed an interest deduction of up to $2,500. You don’t need to itemize to be eligible for this deduction.
Eligibility
To be eligible for a student loan interest deduction, proceeds used to pay for educational expenses must be:
- For you, your spouse, or a person who was your dependent when you took out the loan.
- Paid or incurred within a reasonable period before or after you took out the loan.
- For education provided during an academic period for an eligible student.
Limitations
- You can not be claimed by someone else on their tax return as a dependent.
- You can not file as Married Filing Separate.
- You can not claim the deduction if you are legally not obligated to pay interest on a qualified student loan.
- You cannot claim a student loan interest deduction if your MAGI is $80,000 or more ($160,000 or more if you file a joint return).
Claiming the Credit
Your lender or bank would provide you with Form 1098-E if you paid more than $600 in interest payments during the year. Enter the allowable amount on line 33 (Form 1040) to claim the deduction.
How much is the deduction worth?
The amount of your student loan interest deduction is phased out (gradually reduced) if your MAGI is between $65,000 and $80,000 ($130,000 and $160,000 if you file a joint return).
There’s plenty more information available on the IRS website.
